Europe

Profits have always been important for the chemical industry. That's a given. And many factors affect a company's profitability. In 2003, instead of a forecasted upturn, the economy went into a holding pattern--one that's expected to continue into this year--so European chemical companies had to concentrate on the only part of the profitability equation they see as being directly under their control: costs.

ICI's chairman, Alexander Lord Trotman, articulated a sentiment shared by chemical industry executives when the company reported its third-quarter results in November. Trotman told investors that in 2004 ICI will place "greater emphasis on profit and cash generation." However, he added, the company "believes it is unlikely to reach its targets without a step change in cost and capital effectiveness. ICI will seek to substantially improve effectiveness in fixed- and variable-cost management and in working-capital and fixed-capital efficiency."

Controlling costs, indeed, has become almost the mantra of the industry. This task has always been important for managers, but over the past year, it has taken on added urgency. And 2004 presents no clear signs of upturn for the chemical industry.

However, there are signs of improvement for Europe's general economy, says Jean-Philippe Cotis, chief economist of the Organization for Economic Cooperation & Development. "The strong momentum already achieved in Asia, North America, and the U.K. provides ample evidence of the renewed strength of the world economy. Despite lingering domestic weaknesses, continental Europe is also on its way to join the recovery," he said at OECD's November press conference in Paris to present the organization's latest economic outlook.

However, as Jürgen Hambrecht, chairman of BASF, put it in December while wearing his hat as president of the German Chemical Industry Association (VCI): "For some weeks, first signs have been pointing to a pickup in the global economy. But in the German chemical industry, we have felt nothing of this trend so far. Except for minor fluctuations, this year the chemical output stagnated."

Production of chemicals in Germany, the largest economy within Europe, was up a meager 0.5% in 2003 over 2002. And for 2004, it is projected to show only a modest growth of 1.5%.

In fact, German chemical industry performance probably outdid the performance of Europe as a whole. Early indications are that output in the European chemical industry in 2003 showed a slight decline of 0.5%. That was in sharp contrast to the bullish outlook presented by the European Chemical Industry Council (CEFIC) late in 2002, when economists predicted growth in chemical production of 2.4%. Problems with the economy had already become apparent by mid-2003, however, when projections were slashed to 0.7% growth for the full year.

CEFIC's predictions at that time for 2004 showed considerable optimism, setting growth in production for the region's chemical industry at 2.6%. By the close of 2003, however, that optimism had been dampened somewhat, with the result that chemical industry economists now predict a growth in output of 2% or slightly more above the levels of 2003.

ONE OF THE FEW countries to show strong growth in production in 2003 was the Netherlands. That growth, however, said C. A. Linse, chairman of the Association of the Dutch Chemical Industry, was due in part to the commissioning of a number of new installations throughout the year, as well as the optimization of the production capacity and efficiency of a number of existing installations.

In Germany, production performance varied markedly from sector to sector. For example, production of petrochemicals was off by 1.5%, and polymers output declined 5%. Inorganic basic chemicals output rose 3%, and production of fine and specialty chemicals was up 2.5%. Production of detergents and personal care products increased 6.5%.

In France, production of detergents and personal care products showed similar growth, at 6.3%. Commodity organics were up 0.6%, whereas commodity inorganics production fell by 0.8%; production of specialty chemicals managed 0.4% growth.

Among the more dramatic developments caused by structural change in Europe affecting the chemical industry is the steep decline for fibers, expected to be confirmed in final production figures for 2003. This decline was predicted by CEFIC economists in their forecasts for 2003, reflecting the move to Asia of most of the European textile and garment industries, the main markets for fiber makers. Now, a projection of production data based on the first nine months shows that the drop did indeed materialize.

According to economists at the International Rayon & Synthetic Fibers Committee (CIRFS), based in Brussels, the reasons for the decline are straightforward: Some plants have been closed, and production has been reduced at others. Reductions have occurred because of competition from imports of fibers and because the European customer base for yarn and fabrics is declining as a result of higher imports of apparel from China, India, and Bangladesh.

For the German industry, according to Hambrecht at VCI, 2004 should bring a recovery--"albeit a moderate one. With slightly falling producer prices, we are expecting for 2004 an increase by 1.5% in production and sales. Here our hopes are based mainly on the export business, irrespective of the currently strong euro. However, should the rate of the euro again rise considerably in 2004, this will have a noticeable impact on sales and earnings."

At BASF's annual November press conference to report third-quarter earnings, Hambrecht observed that "the good old days in which one could be certain that an economic downturn would soon be followed by the next upturn are long gone. It is now almost impossible to predict the duration and regional nature of economic cycles.

"In addition," he noted, "other unforeseeable factors can influence economic events. [In 2003] alone, our business was affected by numerous events over which we had no control. The war in Iraq, the severe acute respiratory syndrome epidemic, and the extremely dry weather in Europe and parts of Asia are just a few examples of many. But such events will not change our course. We will continue to improve our regional and product portfolios while maintaining strict cost discipline."

BACK TO COSTS again. Marking time through 2003 gave companies an opportunity to prepare for the return of strong growth. Nonrecurring expenses for restructuring and job losses, combined with modest "fill-in-the-gap" acquisitions, meant that companies took a financial hit in 2003, but they accepted those financial outlays as necessary for the future.

"In a continuing difficult economic environment, we focus on those measures that we can control," said Vice Chairman and Chief Operating Officer David N. Weidman of Celanese when his company reported its third-quarter results in November.

"Our goal is to improve our long-term profitability by focusing on those businesses in which we are market leaders," he explained.

Despite some improving economic indicators, he added, "visibility for the beginning of 2004 remains limited. In the present environment, Celanese will continue to focus on productivity and financial soundness as leading priorities."

Bayer will also be focusing on those businesses in which it has particularly strong market positions: health care, crop science, and specialty materials. Its portfolio reshaping, due to take place this year, is an exception to the small packages of buys and sells that have occupied most of the industry. Bayer plans to launch its chemical operations on the stock market by the end of the year. NewCo, the provisional name of the spin-off, will have sales of more than $6.5 billion--at current exchange rates--in chemical intermediates, chemicals, plastics, and rubber. Innovation and growth will be the main focus for the slimmed-down Bayer, Chairman Werner Wenning says.

On the other hand, for ICI's Trotman, "the economic outlook is, at best, uncertain, and it is clear that ICI cannot rely on improved market conditions to aid profit growth. Consequently, a significant program to improve cost-effectiveness across ICI has been initiated." The program, which was expected to cost the company just under $400 million in 2003, is projected to recoup those costs in savings by 2006.

Some of the savings will come from the loss of about 2,100 jobs by the end of 2005, Trotman conceded. "The program is both radical and far-reaching and is, we believe, a necessary response to today's business realities."

Job cuts also have underpinned cost-cutting efforts elsewhere. For example, Akzo Nobel cut its workforce by 3,360 through restructurings at all three of its business groups, which included divestments of underperforming activities. And what the company terms "a successful focus on cash" trimmed net borrowings by more than $500 million.

The company has expanded its divestment program and this year should see this action affect the sale of catalysts, coating resins, and phosphorus chemicals from its chemicals portfolio "in order to create more room to maneuver for the company," as a company report put it toward the end of last year.

Even in pharmaceuticals, cost-savings programs progressed ahead of schedule, Akzo Nobel executives say, with a workforce reduction of 800 staff in 2003. According to the company, the cuts were "one measure to realign cost levels to decreasing sales volumes." Sales were hit by generic competition in the U.S. for a key drug product, weaker market conditions for fine chemicals synthesis unit Diosynth, and weaker key currencies--that is, a weaker U.S. dollar.

Far from the heady days of a weak euro, when European goods seemed a bargain to the rest of the world, the euro is now substantially stronger than the dollar. As Degussa's chairman, Utz-Hellmuth Felcht, noted last autumn, with every cent stronger that the euro becomes compared with the dollar, the company sees nearly $6 million wiped from its operating earnings.

At BASF, the weak dollar joined other hurdles of high raw material costs and unsatisfactory margins in its chemical businesses as factors that put pressure on the company's results in the fourth quarter. These factors are expected to continue exerting their influence throughout this year.

"We will, therefore, continue to rigorously implement our measures to increase efficiency and reduce costs," Hambrecht said.

In difficult times, he added, "we must remain realistic. We base our assessments on how things are, not on how they should be or how we would like them to be. Even though more and more indicators are positive and pointing upward, we have to rely on facts rather than moods. I therefore think it is too soon to predict when an economic recovery will set in, how strong it will be, and how long it will last."

The company's "fit for the future" project over the past three years, he contended, "has made the whole BASF group more agile and more powerful. The success of such measures lies primarily in our own hands. Even if you're good, there's still always room for improvement."

Some of the improvement in 2004, however, may also feature price increases that companies are battling to put through.

A case in point is Borealis, which achieved an increase in its European polyethylene and polypropylene prices as of September. "Price increases are required to restore profitability to our European business and to sustain our ongoing investment in innovation and technology," according to Chief Executive Officer John Taylor. "We cannot rely solely on continued cost reductions to recover profitability."

WITH THE REGION'S heavy emphasis on exports, chemical industry executives may be able to take some encouragement--at least for the near term--from the results of the latest U.K. quarterly export indicator by logistics company DHL. At the end of December, DHL said chemical exporters in the U.K. "have weathered the tough international trading conditions [of 2003] and are optimistic about prospects for early 2004. In particular, chemical exporters see an increased appetite for their products in many of the 10 so-called accession countries in Central Europe that are set to join the European Union in January," the report added.

All the accession countries and other major countries within the Central European region showed strong gross domestic product growth in 2003, according to the latest transition report of the European Bank for Reconstruction & Development, published in November. That strong performance is expected to continue into this year.

Some 38% of exporters are expecting to increase sales over the next three months, compared with December 2002, when 27% of exporters had that expectation, according to the DHL report. However, it did note that "chemical companies are being more cautious about the long term"--over the next 12 months--with the number of those expecting to increase sales over that period falling to 54% from 58% in December 2002.

But perhaps that caution reflects the experience of the year just gone--a swell beginning and a blah finish. Chemical companies are reluctant to pin their hopes on 2004.